Austerity can’t be ended without significant tax rises or higher levels of debt

Published on 8 July 2017Tax and Welfare

The Chancellor could uncap public sector pay, unfreeze benefits and undo planned departmental spending cuts, but only at the cost of significant tax rises or ripping up his fiscal plans, according to new analysis published today (Saturday) by the Resolution Foundation.

With the shock election result last month leading many politicians to conclude that seven years into spending cuts the public are ‘tired of austerity’, Living with austerity explores the scale of austerity since 2010, the cost of ending it and what doing so would mean for the government’s fiscal plans.

While the public sector pay cap has been the main focal point for the main post-election austerity debate, the Foundation says that moving on that policy alone would be akin to tinkering with austerity, rather than ending it. Twice as many families are affected by the freeze on working age benefits (11.5 million in total), while ongoing departmental spending cuts affect everyone in Britain.

The analysis shows that the public sector workforce is actually facing two ‘austerity crunches’ – shrinking pay packets and a reduced headcount. By 2020, average pay is set to fall back to 2005 levels while the number of central and local government workers is set to fall below five million for the first time this century.

In contrast to some politicians suggestion that the public sector pay cap can be ended “without causing fiscal pressures” the report shows that allowing public sector pay to rise in line with the private sector from next year onwards would cost £9.7bn by 2021-22, while allowing the workforce to grow in line with the population would cost a further £11.5bn over the same period.

The analysis shows that while far more households are affected by the benefit freeze, the cost of unfreezing them would be lower. Allowing working age benefits to rise in line with inflation from next April would cost £3.6bn by 2021-22, while reversing the cuts to Work Allowances in Universal Credit would cost around £3.2bn. Without such changes, welfare support for working age families is set to be 15 per cent below 2010 levels by 2021-22.

Finally, allowing departmental spending (including public sector pay) to rise in line with GDP growth after the end of the current spending review (which runs to 2019-20) would cost £12.3bn by 2021-22. However, this would leave further spending cuts planned for the next two years in place. Reversing these cuts would cost a further £11bn.

The Foundation notes that the Chancellor currently has a £30bn buffer in his fiscal mandate of getting structural borrowing down to below 2% of GDP by 2020-21. While some might argue this could allow him to change tack on public service spending and welfare while still meeting his fiscal rule, doing so would mean borrowing around £100bn more over the next four years than is currently planned and set Britain on course for debt levels to remain above 60 per cent of GDP past 2040.

The Foundation notes that, with weaker than expected GDP and pay growth so far this year, there is a significant risk of the OBR downgrading forecasts for the public finances at the first Autumn Budget. The Chancellor will need to respond to these even before any moves to ‘end austerity’.

The Chancellor has to date ruled out easing elements of austerity with additional borrowing, pointing to a greater role for tax rises, while the Labour Party manifesto called for additional current spending to be paid for from higher taxation. Should the Chancellor choose to look for extra revenues to plug any upcoming fiscal gaps, the report notes there is some low hanging fruit from reversing planned tax cuts, including to corporation tax, which would raise £2.6bn by 2021-22.

And while the Chancellor may not want to announce fresh tax rate rises given the experience of the last Budget, freezing a range of tax thresholds – on income tax and National Insurance – would bring in a further £12.5bn by the end of the parliament. The Foundation notes that this policy of ‘aggressive fiscal drag’ would be progressive, with 78 per cent of the revenues collected from better off households. It would also mark a more sensible balance between tax rises and spending cuts given that tax policy in the 2010 parliament actually made a negative contribution to deficit reduction.

The Foundation says that it’s understandable that politicians want to revisit the austerity debate given the scale of spending reductions that have already taken place and are planned. However, they must face up to the price tags involved and the need for clear prioritisation given the trade-offs between higher public spending and additional borrowing or higher taxes.

It adds that with the latest British Social Attitudes survey finding that support for ‘increase taxes/spend more’ has overtaken ‘keep taxes/spend the same’ for the first time since the financial crisis, the public appear to have got the message about trade-offs, even if some politicians have not.

Matt Whittaker, Chief Economist at the Resolution Foundation, said:

“The shock election result has led politicians from all parties to question whether the public have grown tired of austerity. Seven years on from then Chancellor Osborne’s first emergency Budget, it’s no surprise that squeeze fatigue has set in.

“But recognising that fatigue is very different to doing something about it. If we want a serious discussion on ending austerity, we need to get serious about prioritising what spending we really want to see rise and how we want to pay for it – and that means tax rises for most of us.

“The Chancellor can start by cancelling unneeded corporation tax cuts. But if he wants to raise serious revenues despite the challenges of having a minority government, which the OBR may force him to irrespective of plans to end aspects of austerity, then he could look at freezing tax thresholds, which could raise up to £12.5bn.”

Notes to Editors

Embargoed copies of Living with austerity are available from the press office